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Telecommunications privatizations and international capital markets
Telecommunications privatizations and international capital markets
Samme Thompson
Th& article discusses why equity capital markets, especially in the USA, have found telecommunications privatizations extremely attractive investment opportunities. Raising capital will become harder by the mid-1990s, the author predicts, and he goes on to consider the implications of tighter capital conditions for the future funding efforts of governments and telecommunications administrations.
The concept of private sector participation in the ownership and operation of telecommunications operations is increasingly gaining support from governments and investors worldwide. Prior to the late 1980s, private investment filled a very small portion of the financing needs of national telecommunications administrations around the world, and the amount of private investment that existed often took the form of subscriber contributions in exchange for bonds or shares. More recently a wide variety of programmes have been launched to allow private sector entry into national telecommunications authorities, including: the sale of equity in state-owned telephone operations to private investors or operators; private ownership of operating concessions in areas such as cellular, value-added networks or satellite-based services; subscriber financing proSamme Thompson is Senior Vice President of Kidder, Peabody & Co, Inc, 10 Hanover Square, New York, NY 10005, USA (Tel: + 1 212 510 3168; Fax: + 1 212 797 8942). A version of this paper was presented at the Fourth International Conference on TelecommunicationsPolicy and Regulations, Amsterdam, 23-24 June 1992, and is published with the permission of PA Consulting Group and IBC Technical Services Ltd. 732
grammes; and build-operate-transfer and revenuesharing agreements. In fact, a study recently commissioned by the World Bank persuasively concluded that 'privatization' to date, in its myriad forms, has worked quite effectively in enhancing and accelerating infrastructure developments, based on the cumulative economic gains realized by employees, taxpayers and customers both at home and abroad, as well as the gains to governments and shareholders. I shall comment on the telecommunications privatization process from three perspectives. First I will review some of the reasons why equity capital markets in general, and in the USA in particular, view telecommunications privatizations as extremely attractive investment opportunities. Next I will discuss some of the fundamental reasons why equity capital will inevitably become harder to tap by the mid-1990s. Finally I will offer a few comments on the implications of tighter equity capital conditions for future funding efforts undertaken by governments and telecommunications administrators. EQUITY MARKETS PRIVATIZED PTTs
FAVOUR
Kidder, Peabody estimates that during the past five years over $14 billion were raised in international equity capital markets by governments who have privatized their telecommunications operations. The two principal forms of equity capital have been public stock offerings and private equity investments by US and E u r o p e a n network operators, financial institutions and equipment vendors. In the USA, for example, foreign telecommunications companies are currently traded through the
0308-5961/92/090732-06 © 1992 Butterworth-Heinemann Ltd
Telecommunications privatizations and international capital markets 26g
Standard
and Poors 500
Large-cap telecommunications companies a
Utilities
Figure 1. Growth in stock price, January 1991-June 1992: telecommunications compared with general stock movements. ~Includes AT&T, MCI, Sprint, plus seven RBOCs.
sale of American Depository Receipts ( A D R s ; shares) which are similar to Global Depository Shares (GDS) sold outside the USA on other international exchanges. Recently additional capital has been raised in the USA through the sale of a more restricted quasi-public offering, referred to as 144A stock solicitations. Rule 144A, which applies to a provision of the Securities Exchange Commission's investment code, permits the issuance of common equity shares or share equivalents (such as ADRs) on a more restricted basis whereby shares can only be sold to 'qualified' investors. Qualified investors must meet certain minimum net worth tests. Investor interest in each of these public equity instruments is quite strong. Earlier this year, for example, the government of Argentina raised over $1 billion in its global offering of GDS and 144A A D R s in one of its two telecommunications authorities, Telecom Argentina, which covers Argentina's northern territories. This successful public offering followed a similar offering of shares for Telefonica, Argentina's second telecommunications operation covering the southern territories, which raised nearly $900 million. There are at least three reasons why there is such strong investor interest in foreign telecommunications public offerings. Perhaps the most fundamental is that telecommunications companies in general, and large-cap telecommunication service companies in particular, represent one of the most attractive investment areas for publicly traded stocks (see Figure 1). In the USA large-cap telecommunication stocks have substantially outperformed most other industries included in the S&P 500 listing of large, publicly traded companies; companies comprising the transportation industry represent one exception TELECOMMUNICATIONS POLICY December 1992
that substantially outpaced telecommunications. The overall S&P universe of companies has increased in value by 26% since early 1991, during which time large-cap telecommunication stocks have gained 15% in market price, or nearly $30 billion in market value. A key reason for this impressive performance is increased investor recognition of the rapid progress telecommunications companies are making towards shedding their traditional image as 'utility' companies, poorly equipped to compete on cost or service. This dramatic change in character is largely reflected in the fact that telecommunication stock appreciation has outpaced utility stocks by 2V2 times since early last year. The definition, or composition, of the telecommunications industry is in fact rapidly changing to include both traditional and non-traditional product and services sectors such as information provisioning and wireless as well as wireline technologies. Taking this more broad-based industry definition into consideration, we have an industry valued at nearly $300 billion, generating $240 billion in annual revenue, while growing by 11% annually (see Table 1). While domestic telecommunications in general are very attractive to public equity investors, privatized foreign telecommunications companies are even
Table 1. Selected measures of the US telecommunications industry. ~
Annual revenue generated (1991) Market capitalization (as of 15 June 1992) Capital expenditures (199l) Estimated annual revenue growth rate
$240 billion £280 billion £35 billion 11%
Includes 56 of the largest publicly traded telecommunications companies. Industry segments include carriers, major equipment manufacturers, cellular, cable and telecommunications-based information services providers.
733
Telecommunications privatizations and international capital markets 509
269 159
=
ADRs for six f o r e i g n telcos
S and P index
Domestic telecommunications i n d e x b
Figure 2. Growth in stock price, January 1991-June 1992: foreign versus domestic telecommunications. aIncludes Telefonos de Chile, British Telecom, Hong Kong Telecom, Telecom New Zealand, Tefonica de Espafia. Cable & Wireless. blncludes AT&T, MCI, Sprint, plus seven RBOCs.
more attractive. Note, for example, that the composite stock price for a sample of six foreign telcos that have been publicly traded in the USA for several years has increased by about 50% since early 1991 (see Figure 2). This appreciation would be even greater if we included more recent public offerings. A principal reason for this interest is the tremendous upside growth potential, particularly in the case of less developed countries where telecommunications penetration levels are far below international averages and the potential for improvements in cost structures is well recognized. This public investor enthusiasm is complemented by private investor interest as well. In the past three years US telecommunications companies and financial institutions have invested nearly $10 billion in privatized t e l e c o m m u n i c a t i o n s organizations throughout Latin America, Europe and Asia. Major US and European telecommunications companies are keen to exploit the tremendous opportunities for growth as well as management, technical and capital leverage offered by foreign PTTs. Telecommunications privatization programmes have attracted participation from a number of network operators, equipment providers and banks from Europe, North America and Japan. The bidding process for the sale of Mexico's Telmex, for example, initially attracted 14 consortia of investors. Ownership in newly privatized telcos offers carriers high growth opportunity and greater profit potential than is available in their home-country markets. In their home countries more advanced carriers operate in largely saturated markets, and may be restricted by government regulation from growing 734
-
through entering new service or geographical markets. By taking part in privatization programmes they can often expand basic business - voice service as monopoly operators, while increasing their global market share, efficiency and overall financial performance.
A LESS EUPHORIC EQUITY M A R K E T IS I N E V I T A B L E
CAPITAL
This strong public investor enthusiasm for privatized PTTs notwithstanding, we are not alone in believing that some tightening in the public equity capital markets is inevitable. Four underlying factors support this view. •
•
•
We have all been told about the huge backlog of pending telecommunications privatizations. An estimated 25-30 telcos are due to be privatized by 1995, requiring cumulative capital investment in the order of $145-150 billion. Clearly this or any comparable level of capital demand raises serious questions with regard to capital availability. Further compounding the problem is a need for later-stage financing required by more advanced, or previously privatized, telcos needing to expand their networks or invest in valueadded or high-bandwith services. There are a limited number of major US and European telecommunications companies capable of making several hundred million dollar investments in privatized PTTs. Some of these
TELECOMMUNICATIONS POLICY December 1992
Telecomtnunications privarizadons and mferrmrronal capiful murktts
l
institutions, such as the Bell operating companies, will be increasingly compelled to make huge investments in new high-growth areas such as information services and wireless communications, thus constraining their ability to invest in privatized PTTs; over time these operators will begin to concentrate their investment interests in those areas targeted for strategic growth over the longer term, while limiting participation in otherwise attractive. but lower-priority, investment opportunities. In addition to more sharply focusing their investment and global competitive strategies, telecommunications operators will become further constrained by the availability of management resources to dedicate to new international telecommunications opportunities. As we know, a major benefit to network operators who become involved with newly privatized PTTs is the opportunity to perform key technical, operations and management tasks. This role. of course, also represents an important appeal to public investors, as well as to govcrnment authorities responsible for implementing PIT privatizations.
Increased competition in their home markets is driving miljOr telecommunications companies to further trim their staffs in all areas of management. Fewer skilled managers overall results in fewer management and technical resources available to deploy to investment opportunities abroad.
IMPLICATIONS FOR FUTURE PRIVATIZATIONS
PTT
Despite the changes to global equity market conditions just outlined, government administrations and PTT operators will continue to need substantial amounts of external capital to meet compelling national telecommunications objectives. A recent World Bank study concluded that telecommunications organizations throughout the developing world will gcncratc internal cash flows sufficient to meet only 60% of their capital needs. Furthermore, the pivotal nature of telecommunications to countries’ higher-order economic. commercial and social development objectives is compelling governments to stay the course in terms of their ambitious telecommunications expansion and scrvicc enhancement objectives. despite difficulties encountered in obtaining the necessary capital for growth and developmenl.
TELECOMMUNICATIONS
POLICY
December
1992
Skilfully
pursue multiple capital sources
Perhaps the most obvious impact of tighter conditions in global equity markets is the need for governments and telecommunications administrators to more aggressively pursue multiple capital sources, particularly tapping the global debt markets. Government administrators and their advisors will need to become increasingly skilled at managing more intricate capital solicitation efforts. This process will require a keen understanding of the unique advantages and disadvantages associated with each method of external funding. The issue is not one of capital availability. It is one of who gets it and under what terms. In general, issues involved in selecting and obtaining different forms of external credit include: the availability of credit at the time it is needed; terms and conditions of credit; wider economic effects that credit will have on the borrowing country; and the formation of suitable policies for management and administration of debt. Investment advisors. telecommunications operators and policy administrators must keep in mind that inexpensive funds can bccornc expensive if they are not utilized effectively. A poorly managed project may not gcncrate the required revenue and cash flow to meet debt repayment obligations. We expect to see considerable increase in the use of essentially all forms of external funding, including bank debt financings, vendor financing, multilateral and bilateral agency financings, to mention a few. A major challenge for governrncnt administrations and privatized telecommunications operators will be to ensure that their financial objectives and management structures are adjusted to accommodate the additional burdens that various sources of external debt obligations impose. For example. major borrowings from international banks will typically result in minimum balance sheet ratio rcquircments or other performance measures. Bilateral and multilateral financings can also often require elaborate and lengthy periods of due diligence. Finally, governments will riced to re-evaluate their tariff structures aud build-out schedules to ensure that their privatized telcos are able to meet debt service requirements while also generating sufficiently high returns to continue attracting high-calibre network operators as fdvoured private equity investors. Select the right privatization Tighter financing on the strategy.
strategy
market conditions plus more complex approaches translate into higher premiums design and execution of privatization Many diffcrcnt privatization strategy op-
735
Telecommunications
prwatizorrons and rrmtrmrior~rd cupiloI murkcw
tions are available. Choosing the right strategy at the outset will become increasingly important, since delays in execution or sub-par result5 can be extremely costly or outright disastrous. The privatized tclco may be sold as a single entity. or as separate entities divided along regional or service lines. Argentina, for example, opted to split its PI”I’, Entel, into two regional operating companies bcforc privatizing, while Mexico opted to maintain Telcfonos de Mexico (Telmex) as a single entity. Size and manageability arc often major considerations in this decision. Countries with large networks. for example, may choose to divide their telephone companies along regional lines before privatiring them. Opting for the proper privatization strategy also means choosing the proper approach for selling equity in the privatized company. A large stake comprising the majority of shares or majority voting control may bc sold to a single investor or a consortium of investors through a competitive bidding process. Investors may consist of local and foreign operating companies, financial entities or other investors depending on bidding conditions. Other strategies involve the floating of shares on local or international markets. Most privatization processes have involved a combination of these methods. Of course, the government’s financial objectives will strongly influence privatization strategy. In addition to the goal of obtaining the highest possible sales price, more specific financial objectives such as the need to immediately obtain hard currency or rctirc foreign debt will also determine the type and tel.ms of the sales transaction carried out by the government. These needs may also dictate whether payment of the purchase price may be required in cash at the time of closing and/or in additional l’uture instalL ments. In some instances a portion of lhe purchase price may be payable through debt-equity swaps. Two critical elements of privatization strategy that investors and lenders will undoubtedly focus on in the future will be the government’s underlying regulatory and tariff requirements: 0
0
The
736
Establishment of appropriate regulatory regimes which rcflcct the funding requirements of expansion and the increasing competition in the international financial markets should rcIlecl tarilfs. Accounting structure5 for domestic service and international settlcmcnts should be designed to secure an adequate stream of cash flow for investment in expantion of the network. ability
of a government
to
ensure
that
its
network development objectives are met through privatization depends largely on the effectiveness of the regulatory agency that oversees the sector. An agency without sul’ficient authority or expcricnce may not be able to facilitate or enforce requirements for network development or service standards. Minimize creditors
real and perceived risks to investors and
Investor interest is essentially determined by the pcrccived costs and/or risks of investment weighed against their potential return. Governments can facilitate this process by making available information regarding the telecommunications company’s value and potential for the investor’s capital, technical and management resoul-ces to improve performance. Costs are largely determined by the government’s asking price for the stake in the telephone company, plus investment necessary to meet network expansion, service, quality and regulatory requiremcnts. Other costs may include the impacts of taxation policy and restrictions on repatriation of profits, as well as pcnaltiea I‘or non-compliance with operational and regulatory requirements. Returns depend largely on the privatized telco’s addressable market. As described above, telco5 may bc structured to serve Tpecific regional or service markets. The size of the market, and under what conditions it will be split with other competitors, are key determinants ol’ profit potential. Tariff policy and allowable methods ol‘ financing growth will also affect returns. Governments seeking to privaliLe their telephone administrations have a considerable degree of control over these factors, and can influence investor response accordingly. The government of Puerto Rico. for cxamplc, failed in its attempt to privatize its teleco~~imunicatiorls administration by asking too high a sale price. Several governments have sought to minimize risks and increase returns by making provisions to create a favourahle tariff structure and protect the monopoly statu5 of the operation post-privatization. For example. many governments will guarantee the monopoly status of the privatized operator in its core business to allow it to improve and expand facilities before facing the threat of competition. In Argentina monopoly protection will last for up to 10 years as long as the new owners comply with network expansion and scrvicc quality goals. Telmex will he allowed to maintain its monopoly over local and trunk services until 1996. In addition to the guidelines of the privatization programme, the dcgrce of seriousness and organization with which a govern-
TELECOMMUNICATIONS
POLICY
December
1992
Trlecommunrculiom privufizu/ions und inlernufionul capital mnrkets
ment carries out the programme will either encourage or discourage potential investors and creditors. The increasing competition for capita1 among privatizcd tclccommunications companies around the world means that every dollar cxpcnded should he targeted to achieve the maximum benefit. Stated another way, governments should carefully plan the types and levels of services being provided to achieve optima1 levels of penetration and capacity. There are significant poli,cy and financial issues to be confronted by the parttcrpants in any country’s efforts to expand its tclccommunications infrastructure: the conflicting objectives of financial investors versus domestic economic requirements; the need to attract management skills and technology from the international telecommunications operators; rapidly
TELECOMMUNICATIONS
POLICY
December 1992
evolving technology; and the appropriate regulatory regimes. present difficult policy choices.
establishment of All these factors
CONCLUSION While many of us in the financial community share the view that some tightening in global capital markets will inevitably occur in the next few years, WC also expect to continue seeing record numbers of successful capitalization efforts being completed for those privatized telecommunications authorities who can offer compelling prospects for growth, economic stability and attractive investor returns.
737
Samme Thompson
Th& article discusses why equity capital markets, especially in the USA, have found telecommunications privatizations extremely attractive investment opportunities. Raising capital will become harder by the mid-1990s, the author predicts, and he goes on to consider the implications of tighter capital conditions for the future funding efforts of governments and telecommunications administrations.
The concept of private sector participation in the ownership and operation of telecommunications operations is increasingly gaining support from governments and investors worldwide. Prior to the late 1980s, private investment filled a very small portion of the financing needs of national telecommunications administrations around the world, and the amount of private investment that existed often took the form of subscriber contributions in exchange for bonds or shares. More recently a wide variety of programmes have been launched to allow private sector entry into national telecommunications authorities, including: the sale of equity in state-owned telephone operations to private investors or operators; private ownership of operating concessions in areas such as cellular, value-added networks or satellite-based services; subscriber financing proSamme Thompson is Senior Vice President of Kidder, Peabody & Co, Inc, 10 Hanover Square, New York, NY 10005, USA (Tel: + 1 212 510 3168; Fax: + 1 212 797 8942). A version of this paper was presented at the Fourth International Conference on TelecommunicationsPolicy and Regulations, Amsterdam, 23-24 June 1992, and is published with the permission of PA Consulting Group and IBC Technical Services Ltd. 732
grammes; and build-operate-transfer and revenuesharing agreements. In fact, a study recently commissioned by the World Bank persuasively concluded that 'privatization' to date, in its myriad forms, has worked quite effectively in enhancing and accelerating infrastructure developments, based on the cumulative economic gains realized by employees, taxpayers and customers both at home and abroad, as well as the gains to governments and shareholders. I shall comment on the telecommunications privatization process from three perspectives. First I will review some of the reasons why equity capital markets in general, and in the USA in particular, view telecommunications privatizations as extremely attractive investment opportunities. Next I will discuss some of the fundamental reasons why equity capital will inevitably become harder to tap by the mid-1990s. Finally I will offer a few comments on the implications of tighter equity capital conditions for future funding efforts undertaken by governments and telecommunications administrators. EQUITY MARKETS PRIVATIZED PTTs
FAVOUR
Kidder, Peabody estimates that during the past five years over $14 billion were raised in international equity capital markets by governments who have privatized their telecommunications operations. The two principal forms of equity capital have been public stock offerings and private equity investments by US and E u r o p e a n network operators, financial institutions and equipment vendors. In the USA, for example, foreign telecommunications companies are currently traded through the
0308-5961/92/090732-06 © 1992 Butterworth-Heinemann Ltd
Telecommunications privatizations and international capital markets 26g
Standard
and Poors 500
Large-cap telecommunications companies a
Utilities
Figure 1. Growth in stock price, January 1991-June 1992: telecommunications compared with general stock movements. ~Includes AT&T, MCI, Sprint, plus seven RBOCs.
sale of American Depository Receipts ( A D R s ; shares) which are similar to Global Depository Shares (GDS) sold outside the USA on other international exchanges. Recently additional capital has been raised in the USA through the sale of a more restricted quasi-public offering, referred to as 144A stock solicitations. Rule 144A, which applies to a provision of the Securities Exchange Commission's investment code, permits the issuance of common equity shares or share equivalents (such as ADRs) on a more restricted basis whereby shares can only be sold to 'qualified' investors. Qualified investors must meet certain minimum net worth tests. Investor interest in each of these public equity instruments is quite strong. Earlier this year, for example, the government of Argentina raised over $1 billion in its global offering of GDS and 144A A D R s in one of its two telecommunications authorities, Telecom Argentina, which covers Argentina's northern territories. This successful public offering followed a similar offering of shares for Telefonica, Argentina's second telecommunications operation covering the southern territories, which raised nearly $900 million. There are at least three reasons why there is such strong investor interest in foreign telecommunications public offerings. Perhaps the most fundamental is that telecommunications companies in general, and large-cap telecommunication service companies in particular, represent one of the most attractive investment areas for publicly traded stocks (see Figure 1). In the USA large-cap telecommunication stocks have substantially outperformed most other industries included in the S&P 500 listing of large, publicly traded companies; companies comprising the transportation industry represent one exception TELECOMMUNICATIONS POLICY December 1992
that substantially outpaced telecommunications. The overall S&P universe of companies has increased in value by 26% since early 1991, during which time large-cap telecommunication stocks have gained 15% in market price, or nearly $30 billion in market value. A key reason for this impressive performance is increased investor recognition of the rapid progress telecommunications companies are making towards shedding their traditional image as 'utility' companies, poorly equipped to compete on cost or service. This dramatic change in character is largely reflected in the fact that telecommunication stock appreciation has outpaced utility stocks by 2V2 times since early last year. The definition, or composition, of the telecommunications industry is in fact rapidly changing to include both traditional and non-traditional product and services sectors such as information provisioning and wireless as well as wireline technologies. Taking this more broad-based industry definition into consideration, we have an industry valued at nearly $300 billion, generating $240 billion in annual revenue, while growing by 11% annually (see Table 1). While domestic telecommunications in general are very attractive to public equity investors, privatized foreign telecommunications companies are even
Table 1. Selected measures of the US telecommunications industry. ~
Annual revenue generated (1991) Market capitalization (as of 15 June 1992) Capital expenditures (199l) Estimated annual revenue growth rate
$240 billion £280 billion £35 billion 11%
Includes 56 of the largest publicly traded telecommunications companies. Industry segments include carriers, major equipment manufacturers, cellular, cable and telecommunications-based information services providers.
733
Telecommunications privatizations and international capital markets 509
269 159
=
ADRs for six f o r e i g n telcos
S and P index
Domestic telecommunications i n d e x b
Figure 2. Growth in stock price, January 1991-June 1992: foreign versus domestic telecommunications. aIncludes Telefonos de Chile, British Telecom, Hong Kong Telecom, Telecom New Zealand, Tefonica de Espafia. Cable & Wireless. blncludes AT&T, MCI, Sprint, plus seven RBOCs.
more attractive. Note, for example, that the composite stock price for a sample of six foreign telcos that have been publicly traded in the USA for several years has increased by about 50% since early 1991 (see Figure 2). This appreciation would be even greater if we included more recent public offerings. A principal reason for this interest is the tremendous upside growth potential, particularly in the case of less developed countries where telecommunications penetration levels are far below international averages and the potential for improvements in cost structures is well recognized. This public investor enthusiasm is complemented by private investor interest as well. In the past three years US telecommunications companies and financial institutions have invested nearly $10 billion in privatized t e l e c o m m u n i c a t i o n s organizations throughout Latin America, Europe and Asia. Major US and European telecommunications companies are keen to exploit the tremendous opportunities for growth as well as management, technical and capital leverage offered by foreign PTTs. Telecommunications privatization programmes have attracted participation from a number of network operators, equipment providers and banks from Europe, North America and Japan. The bidding process for the sale of Mexico's Telmex, for example, initially attracted 14 consortia of investors. Ownership in newly privatized telcos offers carriers high growth opportunity and greater profit potential than is available in their home-country markets. In their home countries more advanced carriers operate in largely saturated markets, and may be restricted by government regulation from growing 734
-
through entering new service or geographical markets. By taking part in privatization programmes they can often expand basic business - voice service as monopoly operators, while increasing their global market share, efficiency and overall financial performance.
A LESS EUPHORIC EQUITY M A R K E T IS I N E V I T A B L E
CAPITAL
This strong public investor enthusiasm for privatized PTTs notwithstanding, we are not alone in believing that some tightening in the public equity capital markets is inevitable. Four underlying factors support this view. •
•
•
We have all been told about the huge backlog of pending telecommunications privatizations. An estimated 25-30 telcos are due to be privatized by 1995, requiring cumulative capital investment in the order of $145-150 billion. Clearly this or any comparable level of capital demand raises serious questions with regard to capital availability. Further compounding the problem is a need for later-stage financing required by more advanced, or previously privatized, telcos needing to expand their networks or invest in valueadded or high-bandwith services. There are a limited number of major US and European telecommunications companies capable of making several hundred million dollar investments in privatized PTTs. Some of these
TELECOMMUNICATIONS POLICY December 1992
Telecomtnunications privarizadons and mferrmrronal capiful murktts
l
institutions, such as the Bell operating companies, will be increasingly compelled to make huge investments in new high-growth areas such as information services and wireless communications, thus constraining their ability to invest in privatized PTTs; over time these operators will begin to concentrate their investment interests in those areas targeted for strategic growth over the longer term, while limiting participation in otherwise attractive. but lower-priority, investment opportunities. In addition to more sharply focusing their investment and global competitive strategies, telecommunications operators will become further constrained by the availability of management resources to dedicate to new international telecommunications opportunities. As we know, a major benefit to network operators who become involved with newly privatized PTTs is the opportunity to perform key technical, operations and management tasks. This role. of course, also represents an important appeal to public investors, as well as to govcrnment authorities responsible for implementing PIT privatizations.
Increased competition in their home markets is driving miljOr telecommunications companies to further trim their staffs in all areas of management. Fewer skilled managers overall results in fewer management and technical resources available to deploy to investment opportunities abroad.
IMPLICATIONS FOR FUTURE PRIVATIZATIONS
PTT
Despite the changes to global equity market conditions just outlined, government administrations and PTT operators will continue to need substantial amounts of external capital to meet compelling national telecommunications objectives. A recent World Bank study concluded that telecommunications organizations throughout the developing world will gcncratc internal cash flows sufficient to meet only 60% of their capital needs. Furthermore, the pivotal nature of telecommunications to countries’ higher-order economic. commercial and social development objectives is compelling governments to stay the course in terms of their ambitious telecommunications expansion and scrvicc enhancement objectives. despite difficulties encountered in obtaining the necessary capital for growth and developmenl.
TELECOMMUNICATIONS
POLICY
December
1992
Skilfully
pursue multiple capital sources
Perhaps the most obvious impact of tighter conditions in global equity markets is the need for governments and telecommunications administrators to more aggressively pursue multiple capital sources, particularly tapping the global debt markets. Government administrators and their advisors will need to become increasingly skilled at managing more intricate capital solicitation efforts. This process will require a keen understanding of the unique advantages and disadvantages associated with each method of external funding. The issue is not one of capital availability. It is one of who gets it and under what terms. In general, issues involved in selecting and obtaining different forms of external credit include: the availability of credit at the time it is needed; terms and conditions of credit; wider economic effects that credit will have on the borrowing country; and the formation of suitable policies for management and administration of debt. Investment advisors. telecommunications operators and policy administrators must keep in mind that inexpensive funds can bccornc expensive if they are not utilized effectively. A poorly managed project may not gcncrate the required revenue and cash flow to meet debt repayment obligations. We expect to see considerable increase in the use of essentially all forms of external funding, including bank debt financings, vendor financing, multilateral and bilateral agency financings, to mention a few. A major challenge for governrncnt administrations and privatized telecommunications operators will be to ensure that their financial objectives and management structures are adjusted to accommodate the additional burdens that various sources of external debt obligations impose. For example. major borrowings from international banks will typically result in minimum balance sheet ratio rcquircments or other performance measures. Bilateral and multilateral financings can also often require elaborate and lengthy periods of due diligence. Finally, governments will riced to re-evaluate their tariff structures aud build-out schedules to ensure that their privatized telcos are able to meet debt service requirements while also generating sufficiently high returns to continue attracting high-calibre network operators as fdvoured private equity investors. Select the right privatization Tighter financing on the strategy.
strategy
market conditions plus more complex approaches translate into higher premiums design and execution of privatization Many diffcrcnt privatization strategy op-
735
Telecommunications
prwatizorrons and rrmtrmrior~rd cupiloI murkcw
tions are available. Choosing the right strategy at the outset will become increasingly important, since delays in execution or sub-par result5 can be extremely costly or outright disastrous. The privatized tclco may be sold as a single entity. or as separate entities divided along regional or service lines. Argentina, for example, opted to split its PI”I’, Entel, into two regional operating companies bcforc privatizing, while Mexico opted to maintain Telcfonos de Mexico (Telmex) as a single entity. Size and manageability arc often major considerations in this decision. Countries with large networks. for example, may choose to divide their telephone companies along regional lines before privatiring them. Opting for the proper privatization strategy also means choosing the proper approach for selling equity in the privatized company. A large stake comprising the majority of shares or majority voting control may bc sold to a single investor or a consortium of investors through a competitive bidding process. Investors may consist of local and foreign operating companies, financial entities or other investors depending on bidding conditions. Other strategies involve the floating of shares on local or international markets. Most privatization processes have involved a combination of these methods. Of course, the government’s financial objectives will strongly influence privatization strategy. In addition to the goal of obtaining the highest possible sales price, more specific financial objectives such as the need to immediately obtain hard currency or rctirc foreign debt will also determine the type and tel.ms of the sales transaction carried out by the government. These needs may also dictate whether payment of the purchase price may be required in cash at the time of closing and/or in additional l’uture instalL ments. In some instances a portion of lhe purchase price may be payable through debt-equity swaps. Two critical elements of privatization strategy that investors and lenders will undoubtedly focus on in the future will be the government’s underlying regulatory and tariff requirements: 0
0
The
736
Establishment of appropriate regulatory regimes which rcflcct the funding requirements of expansion and the increasing competition in the international financial markets should rcIlecl tarilfs. Accounting structure5 for domestic service and international settlcmcnts should be designed to secure an adequate stream of cash flow for investment in expantion of the network. ability
of a government
to
ensure
that
its
network development objectives are met through privatization depends largely on the effectiveness of the regulatory agency that oversees the sector. An agency without sul’ficient authority or expcricnce may not be able to facilitate or enforce requirements for network development or service standards. Minimize creditors
real and perceived risks to investors and
Investor interest is essentially determined by the pcrccived costs and/or risks of investment weighed against their potential return. Governments can facilitate this process by making available information regarding the telecommunications company’s value and potential for the investor’s capital, technical and management resoul-ces to improve performance. Costs are largely determined by the government’s asking price for the stake in the telephone company, plus investment necessary to meet network expansion, service, quality and regulatory requiremcnts. Other costs may include the impacts of taxation policy and restrictions on repatriation of profits, as well as pcnaltiea I‘or non-compliance with operational and regulatory requirements. Returns depend largely on the privatized telco’s addressable market. As described above, telco5 may bc structured to serve Tpecific regional or service markets. The size of the market, and under what conditions it will be split with other competitors, are key determinants ol’ profit potential. Tariff policy and allowable methods ol‘ financing growth will also affect returns. Governments seeking to privaliLe their telephone administrations have a considerable degree of control over these factors, and can influence investor response accordingly. The government of Puerto Rico. for cxamplc, failed in its attempt to privatize its teleco~~imunicatiorls administration by asking too high a sale price. Several governments have sought to minimize risks and increase returns by making provisions to create a favourahle tariff structure and protect the monopoly statu5 of the operation post-privatization. For example. many governments will guarantee the monopoly status of the privatized operator in its core business to allow it to improve and expand facilities before facing the threat of competition. In Argentina monopoly protection will last for up to 10 years as long as the new owners comply with network expansion and scrvicc quality goals. Telmex will he allowed to maintain its monopoly over local and trunk services until 1996. In addition to the guidelines of the privatization programme, the dcgrce of seriousness and organization with which a govern-
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POLICY
December
1992
Trlecommunrculiom privufizu/ions und inlernufionul capital mnrkets
ment carries out the programme will either encourage or discourage potential investors and creditors. The increasing competition for capita1 among privatizcd tclccommunications companies around the world means that every dollar cxpcnded should he targeted to achieve the maximum benefit. Stated another way, governments should carefully plan the types and levels of services being provided to achieve optima1 levels of penetration and capacity. There are significant poli,cy and financial issues to be confronted by the parttcrpants in any country’s efforts to expand its tclccommunications infrastructure: the conflicting objectives of financial investors versus domestic economic requirements; the need to attract management skills and technology from the international telecommunications operators; rapidly
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POLICY
December 1992
evolving technology; and the appropriate regulatory regimes. present difficult policy choices.
establishment of All these factors
CONCLUSION While many of us in the financial community share the view that some tightening in global capital markets will inevitably occur in the next few years, WC also expect to continue seeing record numbers of successful capitalization efforts being completed for those privatized telecommunications authorities who can offer compelling prospects for growth, economic stability and attractive investor returns.
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